Words don’t come easily to Josephine Meddings when discussing her finances. The 71-year-old resident of Warrnambool, three hours west of Melbourne, saw her nest egg of $216,000 caught up in the collapse of Banksia Securities.

She is unsure of how to describe the business to which she entrusted her savings, saying: “I don’t know much about banks or Banksia." She used to be a customer of Commonwealth Bank “but I didn’t like that at all," she says, so she switched.

“I’m feeling really bad about it," she tells The Weekend Financial Review of having her life savings in the hands of Banksia’s receivers. “That was my income that I was planning to live off."

There are tens of thousands of Australians who, like Meddings, have been burnt by failed debenture companies, and the question of what to do with these operations has drifted in and out of the attention of regulators and Canberra for much of the past decade.

The thinking, which tracks back through previous chairmen of the Australian Securities and Investments Commission Jeff Lucy and
Tony D’Aloisio
, is caveat emptor – buyer beware.

Provided companies disclose the risks in a prospectus, they are free to sell any financial product they can think of. Critics say Australia is the only place in the world that does not save retail investors from themselves by restricting the types of products they can buy.

It’s a philosophical debate that turns on how you see the rights and duties of individuals to look after their own interests versus heavy-handed state intervention.

But to look beyond the theory and get into the practice, you have to look at Banksia through the eyes of people in the small Victorian towns where it operated.

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Banksia was an issuer of debentures, a type of debt instrument that offers a fixed rate of return. The money was used to invest in property, secured by mortgages. It went under after a review of the loan book by a new chief executive officer suggested a lot more loans were likely to go sour than the previous management had realised.

With just $4 million set aside to cover losses on a loan book of $470 million, and less than half the capital that a genuine bank would have had to hold, the revised estimate of loan losses meant the company was insolvent, hence receivers were called in.

Banksia was a “non-bank", to use a financial industry term, and subject to far less oversight than real banks. But the distinction doesn’t mean much to people in Kyabram, a small Victorian town near the NSW border.

Judith, an 80-year-old retired dairy farmer from Kyabram, had a comparatively small amount of savings in Banksia, but other family members have lost more. She says many people in the town effectively used it like a bank, withdrawing money whenever they wanted – which Banksia facilitated through offering at-call deposit accounts, like a bank.

Judith says she earned just a 5 per cent return on her debenture investment – a yield she could have got from a term deposit or even an at-call account online. Asked why she put her money into Banksia instead, her response is simple – after she was married in the 1950s she invested the proceeds from the sale of a farm in the mortgage investment company operated by Kyabram’s solicitors, Morrison & Sawers. She has had money with them ever since. It was the company that turned into Banksia.

Needless to say Judith, which is not her real name, did not read Banksia’s 32-page prospectus. Even if she had, she wouldn’t necessarily have realised that $4 million in provisions against a $470 million loan book was risky. It’s also unclear whether she would have realised how important it was that Banksia’s “equity ratio" of 3.5 per cent was well below ASIC’s suggested ratio of 8 per cent.

In the eyes of ASIC what mattered was that these risks were disclosed in the prospectus.

For Judith what mattered was that Banksia had a bricks-and-mortar presence in the town where she had lived for most of her life. “It was a Kyabram local institution. They were an institution of the town. They have been there so long," she says.

On the other side of Victoria, in Warrnambool, Meddings also didn’t read Banksia’s prospectus before handing over the proceeds from the sale of her house following the death of her husband 10 years ago. How did she come across Banksia? “I just saw them in the street, and the girl there was very helpful. She said she wouldn’t put anyone into something that she wouldn’t put [money] into herself."

ASIC already knows a lot about these types of people – in the past five years 15 businesses similar to Banksia have collapsed owing $1.5 billion, and that’s not including other shadow bankers like Westpoint, Fincorp and Australian Capital Reserve.

In 2008, ASIC profiled investors in the Fincorp and ACR collapses and found investors fell into two broad categories. The biggest, just under 54 per cent, had an average age of 64 and were more likely to be female. They were likely to be widowed or divorced, receiving some form of government support and tended to have been educated to high school level or below.

They are attracted by investments that they perceive to offer security and were influenced by advertising, seeing the frequency of advertising as a proxy for quality, ASIC’s report said.

To a profile of Banksia victims it should be added that investors were overwhelmingly from regional areas where major banks are unpopular after branch closures in the 1990s. Victorian Farmers Federation vice-president Peter Tuohey says Banksia was highly trusted by many farmers.

“The reason why they go to these lenders is because they see the big banks taking them for all they can get, not passing on interest rate cuts. Banksia were very competitive, and they were a local business that had been around for quite a while," he says.

It was while combing through the profiles of Banksia’s victims that ASIC chairman
Greg Medcraft
this week decided to set up a special taskforce into the collapse, with an eye to suggesting changes to how the sector is regulated. The ASIC commissioner who will run the taskforce, John Price, admits things must change. “We feel we have pushed the disclosure regime to the limit," he says.

One option for reform would be to follow New Zealand, where 50 non-bank lenders collapsed in quick succession during the global financial crisis and where the Reserve Bank of New Zealand now has a form of prudential supervision over the sector. In a paper issued earlier this year, the RBNZ noted the failures devastated the savings of many New Zealanders.

“In hindsight the heavy reliance on disclosure to market participants [i.e. market discipline] did not work as intended," the RBNZ said.

This supervision is less onerous than the RBNZ’s supervision of real banks, but it is far more exacting than the current Australian approach whereby as long as companies disclose their risks they can continue to raise money. But ASIC’s Price cautions that introducing such a reform into Australia would be an enormous change to its “very free market" approach to investment products.

That approach extends back to the 1997 Wallis Inquiry, which established both the Australian Prudential Regulation Authority, which closely monitors the financial strength of a few dozen banks and insurance companies, and ASIC itself, which provides a far lighter regulatory touch to thousands of non-bank financial companies.

ASIC’s philosophy of allowing investors to invest in whatever they like provided they have been warned of the risks underpins Australia’s entire investment market. Putting limits on people investing in debentures would prompt questions about other popular retail investments that have raised concerns, such as contracts for difference and bank hybrids.

A less radical proposal for reform, Price says, would be to beef up requirements on trustees, who are supposed to keep an eye on debenture companies to protect investors.

“It’s a matter for government," Price says.

For its part the government has been keeping relatively quiet, with spokesman
Bernie Ripoll
, Parliamentary Secretary to the Treasury, simply saying the government will continue to monitor the situation while waiting for advice from Banksia’s receivers and ASIC.

Once it receives that advice the government will have to answer this question: should more work be done on improving financial literacy and finessing the message about the need to do homework before investing money? Or is the track record of the debenture industry such that companies like Banksia should be put on a tighter leash?